18 June 2024

When tax goes wrong: how to formulate an appropriate strategy

Michael Thomas KC explains in this article first published in Tax Journal how to formulate an appropriate strategy.

Speed read: What approach should be taken to assist a client when tax planning goes wrong? The starting point should be to assemble the best team, which ideally should include tax technical expertise as well as advice in respect of possible litigation, both against HMRC and perhaps also any previous advisers. The taxpayer’s position should then be calmly evaluated at an early stage so that an appropriate strategy is able to be put in place. If the client has a good technical defence, it may be preferable to seek to uphold this, rather than concede the position. At the other end of the spectrum, it is a matter of paying the tax and seeking to win a professional negligence case. The position is inevitably more complicated where the taxpayer has a defensible position but which carries a significant risk of being successfully attacked by HMRC.

The first principle of the rule of law is that ‘all laws should be prospective, open and clear.’ In contrast, far too many regimes within the UK tax code are readily comprehensible only to a sub-group of tax experts who specialise in that particular area. Further, the UK tax system far too often requires the application of rules which are not only extremely complex but also disproportionately so in relation to both the amounts at stake and to the simplicity of the commercial scenarios involved. It is a serious failing of our tax system that this disproportionate complexity positively invites errors, not least because it may be disproportionately costly to take the necessary advice. The Tax Advice Charities (bridge-the-gap.org.uk) well make the point that workers holding down both employed and self-employed engagements within the ‘gig economy’ are subject to a very complicated tax compliance regime. Residential conveyancers are typically tasked with working through the challenging series of rules which have to be applied to determine the applicable rate of SDLT.

There is also currently much renewed publicity concerning tax planning arrangements which are said to be lacking in technical merit, although aggressive tax planning is hardly a new phenomenon. Of course, human nature dictates that clients will be tempted to take risks in pursuit of perceived tax savings. It further dictates that even the best advisers make mistakes. The need to advise at speed to match the demands of deals inevitably decreases overall accuracy. Accordingly, it is inevitable that some clients will end up receiving bad advice. The purpose of this article is not to comment on any particular scenario but rather to consider generally how best to go about assisting such a client.

Where to begin?

The starting point should be to assemble the best team. Who is brought onboard will depend upon the client’s budget together with their initial attitude towards litigation. It is suggested that the client will need both tax technical advice as well as advice in respect of possible litigation, both against HMRC and perhaps also any previous advisers. Potential conflicts may impact upon the ability of those previous advisers to continue to act. If the matter concerns planning arrangements which have been widely marketed then there may be the possibility of clients joining together in order to save costs. Clients who have been sold commoditised planning should obtain an independent view and not merely rely on the promoter.

Before moving forward, it is essential to evaluate the strength or otherwise of the client’s technical position. The first step must be to establish the relevant facts. The importance of the facts is of course not lost on HMRC, who routinely begin all enquiries with an extensive fact-finding exercise. When tax planning arrangements fail this is often due to defective implementation. Establishing the precise facts may also open up technical arguments in the taxpayer’s favour. Addressing the facts and evidence should make it easier to anticipate how HMRC and indeed any judge may approach the matter; impression is important.

Next, the relevant law can be considered and a view taken as to the applicable tax treatment. The strength of any filing positions taken, or self-assessments which have been made on the basis of not filing, can then be evaluated. Potential arguments that HMRC might seek to make must be considered here. Procedural aspects, notably the question of whether HMRC is within time to assess any outstanding tax, must not be overlooked.

The strength of the client’s position, and HMRC’s in relation to it, should be regarded as dynamic rather than static. The perceived merits will change as new facts and legal arguments come to light. Nevertheless, without a full appraisal of the client’s technical position at an early stage, it is all too easy to embark on an inappropriate course. For example, if the client has a good technical defence, then it may be preferable to seek to uphold this rather than concede the position, pay tax and seek to win a professional negligence case. It is useful at this stage to have in mind the so-called ‘Stockdale paradox’, which requires the brutal reality of the situation to be confronted and a successful final outcome envisaged. Success needs to be defined appropriately in line with what outcomes are realistic.

Even within situations where something has gone wrong, there is a very wide spectrum regarding the strength of the clients’ positions. At one end is the situation where the current advisers conclude that the taxpayer has a strongly defensible position which they agree is correct, albeit that perhaps some risk was not originally pointed out. At the other end are situations where investigation shows that the position is hopeless. Cases which sit in the middle of these extremes will often raise difficult questions as to the strength of the analysis and what to do generally.

If HMRC are already engaging with the client, whether by having opened an enquiry or otherwise, then this should determine how the matter will immediately progress. If HMRC are not yet fully engaged then a key step must be to establish what returns have been made and whether there are any outstanding compliance obligations from which payment obligations will follow. It is recommended that this should be dealt with at an early stage, including in order to reduce the exposure to potential penalties. If there are outstanding returns to be filed then this must of course happen without delay and with the attendant tax duly paid. Generally, trying to get on the front foot with HMRC is likely to help secure an optimal outcome. Early engagement should enable the taxpayer to emphasise the strengths in its position and, even in the weakest cases, demonstrate a responsible approach which if nothing else should mitigate penalties and reduce the risk of HMRC using civil (COP 9) or even criminal fraud procedures. A taxpayer with a hopeless technical position, especially where some sort of planning has been attempted, is at risk of being subject to allegations of fraudulent conduct should they become aware of this and fail to swiftly engage with HMRC.

The position becomes more complicated where it is concluded that the taxpayer has a defensible position but one which carries a significant risk of being successfully attacked by HMRC. Detailed advice will need to be taken in respect of individual cases. However, if the advisers conclude that the chances of successfully defending the position are no greater than 50%, then it is expected that a return will need to be filed if that has not already happened. What should then be said in that return, perhaps together with an additional written disclosure, will need to be considered further.

If a return has been submitted and it is subsequently concluded that tax has been mistakenly under-reported, then the position is potentially more difficult and sensitive. It is probably fair to say that neither statute nor case-law satisfactorily deals with the question of whether or in what circumstances a return should be corrected in the event that a mistake is identified.

A taxpayer who makes an unprompted disclosure to HMRC is entitled to a statutory reduction in respect of tax-geared penalties: see especially FA 2007 Sch 24 para 10. The requirements of insurers, the duty to mitigate loss in relation to any professional negligence claim and the desire of both clients and advisers to maintain good relations with HMRC will also typically point towards disclosure.

Professional conduct

Professional conduct obligations must also be considered. Professional Conduct in Relation to Taxation (PCRT) recommends that errors should be disclosed to HMRC and that the adviser should cease to act if the client does not consent. Readers are referred to PCRT Helpsheet C1: Dealing with errors, which contains guidance as to how these situations should be dealt with. However, the PCRT’s definition of ‘error’ seems to be premised on the idea that tax is either due or not which whilst ultimately true, as the highest appeal court gets the final say in any case, does not assist when the situation comes to light and the position is less clear cut. The final section of Helpsheet C1 deals with corrective action and recognises that the position may not be straightforward. Nevertheless, it is arguable that the guidance goes too far, in particular by stating that a later adverse court decision means that clients are generally required to inform HMRC of possible insufficiencies in their own returns. If additional duties are to be imposed on taxpayers that should be done directly by statute rather than by exerting pressure on their advisers through professional standards.

Unfortunately, this kind of issue is going to take even greater prominence given the current consultation on raising standards in the tax advice market. This proposes: ‘Imposing mandatory professional body membership [which] would mean that a tax practitioner who was expelled would either face limitations on the tax advice and services they could provide for clients … or would no longer be able to practice’. A concern is that the relevant rules could be drafted very widely, as with modern tax legislation, so as to brook no disagreement and that a professional doing their best to advise a client could then fall foul of such a new stringent regulatory framework. It is easy to think that this should only concern ‘other rogue advisers’ and be reassured. However, most advisers will encounter clients who wish to self-assess aggressively including by pursuing planning arrangements proposed by others or who, despite the adviser’s own best efforts, have failed to properly implement the advice as well as clients who have been badly advised elsewhere. Such clients need to be able to call upon advisers who are able to give the best advice to help them make the best of imperfect situations. This could be compromised if those advisers are subjected to regulatory requirements which purport to impose duties which go beyond the applicable underlying tax rules. The ability of advisers to defend themselves is yet further complicated by the requirements of client confidentiality. Space precludes additional discussion but the short point is that there are real concerns here.

Duty to disclose?

As to whether there is any general duty to disclose mistakes, in Sanderson v HMRC [2014] STC 915 Newey J, as he then was, held that an adviser was not negligent in not advising their client to inform HMRC of a mistake. He stated that:

Taxpayers are required by statute to submit returns, and every such return will include, in accordance with s8 of the TMA, a declaration by the person making the return that it is correct and complete to the best of his knowledge. In contrast, there is no statutory provision imposing an obligation on a taxpayer to tell HMRC about something in a filed return he subsequently finds to be erroneous. The most that can be said is that a failure to correct in error can potentially affect a taxpayer’s exposure to penalties … There is thus no question of [the advisers] having ignored a provision obliging a taxpayer to correct a return‘.

Newey J further stated that he was unaware of any relevant case-law which holds that a taxpayer has a duty to inform HMRC of past mistakes. Although no final view was expressed, the reasoning clearly supports the conclusion that a taxpayer has no general duty to correct mistakes. This is further supported by the subsequent introduction of the time-limited ‘requirement to correct‘ regime for offshore matters.

Whether to make a disclosure to HMRC in the situation where a return has been filed which covers the mistake is therefore likely to depend upon a range of overlapping factors. A central consideration is likely to be the gravity of the mistake and the strength or weakness of the technical merits, although these may not always correlate. That leads on to the likely approach of HMRC, the ability to defend the position, potential penalties, professional conduct responsibilities and concerns as to ongoing relationships with HMRC together with reputational risk. The impact of dealings with HMRC on alternative remedies must also be borne in mind. If HMRC are known to be making challenges in the particular area or have spotlighted a planning arrangement, then that will also impact. Detailed advice as to what best to do must be taken in individual cases.

The upshot is that there is a wide range of possibilities as to what might be done in relation to HMRC. If it is concluded that the client’s position is hopeless and there are outstanding filing and payment obligations, then these must be complied with. At the other end of the spectrum, where a taxpayer has filed appropriately and has a defensible position, then it may be that the best course is to wait for any enquiry and defend any challenge from HMRC should one arise. That does not mean that the advice is then to simply do nothing. Rather a taxpayer would be well advised to gather and retain as much relevant contemporaneous evidence as possible so that it is ready to respond to any enquiry at an early stage and defend its position. In other cases how best to deal with HMRC may not be straightforward, especially where no enquiry has yet been opened.

Professional negligence actions

Where bad advice has been received then professional negligence actions inevitably fall to be considered. It is to be emphasised that even if defective advice has been received then that does not mean that the client is entitled to full recovery. A number of significant hurdles need to be overcome in order to bring a successful claim. These include the following.

  1. a suitable defendant needs to be identified, preferably – for the sake of both parties – one holding appropriate insurance.
  2. a duty of care to the individual claimant must be established. This can be problematic where commoditised tax planning and schemes have been sold. As an aside, when entering into such planning then it is important that clients take advice which is personal to them. From the perspective of the individual client the temptation is not to because at the time the arrangement is being implemented this looks like needless duplication of expense. However, such independent advice is more likely to objectively identify risks and factual issues, including around implementation.
  3. advice which is sufficiently bad so as to be negligent needs to be identified. This is not as simple as getting things wrong, especially in a tax system as complex as ours.
  4. the advice must have caused the loss. Taking a real-life example, if EIS relief is lost because shares are issued not fully paid up but the client lacked the cash to pay for them in any event then any defective advice will not have caused loss.

In addition, damages will be reduced for the claimant’s contributory negligence and for failure to mitigate loss. For example, inviting penalties by failing to make a voluntary disclosure to HMRC.

There is also the ability to bring in other defendants. This means that, for example, where solicitors have implemented a structure on the basis of defective tax advice from the client’s accountant then the solicitors may be brought in as co-defendants by the accountant’s insurers. This can make life difficult if the claimant still uses that law firm.

Claimants seeking to bring professional negligence actions need to be ready for all of the above areas to be scrutinised by the defendant, in reality the insurer, and their advisers. Needless to say, insurers are well versed in the lines of defence which are available to them. Even claimants with compelling cases need to be ready to work in order to sustain their claims. Moreover, even if a claim succeeds the best result is a negotiated settlement which inevitably falls short of full recovery. Neither will the costs incurred in bringing the claim be fully recoverable.

All of this is of course why it is not advisable to bring a professional negligence claim without first evaluating the technical position. At worst, a claimant could inadvertently give away a good technical argument and severely undermine their professional negligence claim as they will then struggle to prove that any tax was actually due. Where appropriate, a wise strategy may be to enter into a ‘standstill agreement’ with a potential defendant’s insurers so that the professional negligence claimed is ‘parked’ pending resolution of the substantive tax position with HMRC.

It is recommended that advisers remain open-minded as to other potential avenues that may assist. For example, it may be arguable that the arrangements are capable of recission or rectification in a way which assists a more favourable tax analysis. Lobler v HMRC [2015] STC 1893 takes things a step further by providing authority for the proposition that a unilateral mistake as to the tax consequences of a transaction which is sufficiently serious that a court would order recission or rectification means that the tax consequences of that transaction are to be determined as if recission or rectification had actually been ordered. It is fair to say that Lobler is a controversial authority which is understood to be not well regarded by HMRC, including because it may often be invoked as a last resort. Accordingly, it should be treated with some caution. Nevertheless, it is certainly very helpful to taxpayers and there will be cases where it is able to be relied upon. It has been applied on several occasions now, most recently Cooke v HMRC [2024] UKFTT 272 (TC).

Final thoughts

In conclusion, the key challenge is to ensure that the position is calmly evaluated at an early stage so that an appropriate strategy is able to be put in place. This is simply stated but not so easy to execute in practice, where a raft of factors may cause distraction. The chances of an ultimately successful outcome should be maximised by confronting the brutal reality of the client’s position and devising an appropriate strategy.

For related reading visit Tax Journal:

  • Raising standards (P Aplin, 13.3.24)
  • Professional conduct in relation to taxation (M Gammie, 2.3.17)
  • Tax and professional negligence (M Thomas, 6.11.14)

Michael Thomas KC‘s article first appeared in the May 2024 edition of Tax Journal.  For further information about Michael Thomas KC and his practice, please contact the clerks.